How to Buy a Foreclosure Home

You could save a significant amount of money when you buy a foreclosure home. Studies have shown that the average discount for a foreclosed home (when compared to regular, non-distressed properties) is around 27%. When you combine this fact with the high number of foreclosed homes on the market today, you can see why foreclosure-buying fever has swept the country.

But this is not the kind of process you want to rush into. Before you attempt to buy a foreclosure home, you need to understand the process that occurs when a bank forecloses on a house. You must also be familiar with the concept of comparable sales, and how you can use them to evaluate the asking price of a foreclosure property. Lastly, you must understand the offer process. We will discuss all of these things -- and a lot more -- in this tutorial.

Why People Buy Foreclosures in the First Place

Over the years, a secondary industry has evolved around the foreclosure process. Companies like RealtyTrac sell access to foreclosure listings. Buyers and investors use this information to find foreclosed homes for sale in their desired area. But why? What is that motivates these people to buy foreclosure homes in the first place? The answer can be summed up in a single word -- savings.

When you buy a foreclosed home, there is a good chance you'll pay less than market value for the house. According to data compiled by RealtyTrac from 2010 - 2011, foreclosure homes are selling for an average discount of 27%, when compared to non-distressed / non-foreclosed properties. In some states, the potential for savings is even greater. According to the same study, foreclosed homes in Illinois had an average discount of 40% over non-distressed real estate.

Let's plug these percentages into some actual sales scenarios, to see just how much you might save if you buy a foreclosure home. At the national level, foreclosed properties are selling at an average discount of 27%. We learned that from the data collected by RealtyTrac. Here's how it translates into actual dollar amounts...

House #1 is a non-distressed home. This means the homeowners are current on their mortgage payments, and they are selling the home through a normal real estate transaction. The current market value of the home is $300,000. The sellers have listed it for $305,000.

House #2 is a bank-owned foreclosure. The original homeowners have defaulted on their mortgage loan, so the bank has foreclosed on the property. It did not sell at auction, so it's back on the market as an REO / bank-owned home. It is comparable to house #1 above. In fact, it's in the very same neighborhood. The current market value is $300,000. The bank has listed the home for $219,000 (a discount of 27% from the market value).

Is this a realistic scenario? Absolutely. In fact, I used the national average we talked about earlier. The foreclosure property was discounted by 27%, which is the average discount (nationally) determined by the RealtyTrac study. So yes, it's a very realistic scenario. It also explains why so many people are interested in buying foreclosure homes these days. Based on this scenario, a buyer could save $81,000 by purchasing the bank-owned foreclosure home.

Of course, there's no guarantee you'll get a discount like this when buying a foreclosure. But the possibility exists. The data shows this plainly enough. The rest is up to you. If you're a patient and well-informed buyer, there's a very good chance you could buy a foreclosed home at a significant discount. It's basically a shortcut to building equity.

How a Bank Forecloses on a House

The foreclosure process varies from one state to another. For the most part, it's the individual states that determine their foreclosure procedures and laws -- not the federal government. So the exact steps will vary slightly from one state to the next. With that being said, the basic process is generally the same.

The homeowner stops making payments on the loan. The bank eventually forecloses, or repossesses, the home. The bank may try to sell the property at an auction, if they feel there's enough demand. Or they may just list it for sale as an REO / bank-owned home. These are the basic steps that take place, regardless of what state you live in.

The point is, you need to familiarize yourself with the foreclosure process in your state. This is mission critical. It's possible to buy a foreclosure (or a pre-foreclosure) home at any step of this process. But from a buyer's perspective, there are certain pros and cons associated with each stage. So it's crucial that you understand how the process works. Here are the different ways you could buy a distressed home:

Pre-foreclosure short sale -- Sometimes, a homeowner who is struggling to keep up with a mortgage will sell the house before the bank forecloses. If they owe more on the loan than the home is worth (a common scenario these days), it's referred to as a short sale. The proceeds from the sale fall "short" of the loan balance, hence the name. The buyer needs the lender's permission to do this. You could buy a home in this pre-foreclosure stage, and possibly get it for less than market value.

Real estate auction -- Sometimes, when a lender forecloses on a home, they will try to sell it through an auction. You've probably heard about people gathering at the county courthouse for a "sheriff's auction" or a trustee's sale. This is another way to buy foreclosure homes. Properties that aren't sold at auction eventually come back onto the market as bank-owned homes (next item). Some lenders skip the auction process entirely, due to a lack of demand. In these cases, the property moves right into REO status, as defined below.

REO / bank-owned home -- When the home finally comes back onto the market (which can sometimes take weeks or months), it is listed as a bank-owned / REO home. REO stands for real estate owned, which is just an odd way of saying the bank owns the house. The average discount for an REO property is less than the discount for auctioned homes. In other words, you could save more money by buying a foreclosure through an auction. But, as many experts will tell you, purchasing a property that's in a bank-owned status is generally the safest bet. Learn more here

As you can see, there are really three ways to buy a foreclosed home. To be more accurate, there are three ways to buy distressed property -- one strategy before the foreclosure takes place, and two strategies after it takes place. As a buyer, you need to determine which of these strategies works best for you.

If you're a first-time buyer, or if you're not familiar with the process of buying foreclosures, you might be better off sticking to the third option above (bank-owned homes). There are several benefits to buying a bank-owned foreclosure, as compared to a home in the pre-foreclosure or auction phase. For one thing, the homeowner is out of the picture. So you only have to deal with the bank. Secondly, you can be reasonably sure that the property's title is free of liens, because the bank will typically perform an extensive title search before listing the home for sale.

What you need to realize is that the bank wants to sell the home as quickly as possible. They own the property, but there is no mortgage attached to it. The homeowner has defaulted on the loan. So the house is basically a non-performing asset for the bank. They want it off their books, as soon as possible. This is why foreclosures are often priced below their true market value. Remember the 27% statistic from earlier? That was the average discount for a foreclosed home, as reported by RealtyTrac.

Granted, the banks don't give these homes away for nothing. Nor do they care to negotiate with buyers -- not in most cases, anyway. So you may be better off making a full-price offer, rather than trying to low-ball them. Just do your pricing research to see how the home is priced, and make an offer based on that research. We will talk more about this later.

5 Steps to Buying a Foreclosed Home

So we've talked about the potential benefits of buying a foreclosure home. And we've covered the three stages in the process where you could buy such a property (pre-foreclosure, auction and REO status). Now let's talk about how you would buy a foreclosed home.

Note: The process of buying a foreclosure may vary based on where you live. Remember, it's the states that set most of the laws and procedures, not the federal government. With that being said, we highly recommend that all buyers follow the five steps outlined below, at a minimum.

1. Monitor Foreclosure Activity

We talked about the significant potential for savings when buying a foreclosure home. This can attract a lot of buyers and investors. It's a competitive and fast-moving market. If you want to stay on top of the market, you need to sign up for a foreclosure-tracking service.

These companies give you access to foreclosed home listings in your area, as soon as they come onto the market. Some of them provide information on pre-foreclosure listings and real estate auctions, as well. There are several web-based services you can use for this purpose. RealtyTrac.com is one of the most widely respected (and widely used) of these services. RealtyStore.com is also worth a look.

You can also get this kind of information from your local county officials. But you would have to make daily or weekly trips down to their offices to retrieve the information. This can be tedious and time-consuming. With the online tracking services, you can log into a website and have all of the listings at your fingertips. It's much more efficient.

Bottom line: If you want to buy a foreclosure home, you need to stay on top of your market. Things move quickly. There are plenty of other buyers looking for the same good deal that you're after. You need to know about foreclosures as soon as they come onto the market. You can get this from your county offices for free. But the information might be dated and/or inconvenient to obtain. Foreclosure-tracking services are a more efficient tool.

2. Find a Foreclosure-Savvy Real Estate Agent

If you're a first-time home buyer, or a first-time foreclosure buyer, you should enlist the help of an experienced real estate agent. When it comes to distressed property, there are basically three types of real estate agents:

The Reluctant -- Some agents want nothing to do with foreclosures. They are reluctant to get involved with distressed properties. Perhaps they don't fully understand the process of buying a foreclosure. Or maybe they've had a bad experience with it in the past, and have since "sworn off" of these deals entirely. Just know that some agents try to steer their clients away from the foreclosed homes and toward the regular listings.

The Willing -- Some agents are willing to show their clients distressed properties, but they are not familiar with the process of making an offer to buy such a property. They've never been through the process before. Buying a foreclosure is different from a regular real estate transaction. You have to submit your offer to the bank, instead of the homeowner. Some banks require potential buyers to submit an "offer package" with specific items included. These agents may not understand the exact requirements of such an offer.

The Experienced -- Finally, we have the real estate agents who are experienced in this sort of thing. They have helped clients make offers on foreclosed homes in the past. They know the laws and procedures. They know how to expedite the process. This is the kind of agent you should seek, if you're interested in buying distressed property.

As a buyer, you need to be forthcoming about your plans. If you want to focus on distressed properties in an attempt to get a good deal, you need to share this with the agent(s) you are considering. You wouldn't want to get involved with an agent who is "anti-foreclosure." And believe me, there are plenty of them out there.

3. Review Comparable Sales

So, you've decided that buying a foreclosure home is a viable strategy. And you've decided to sign up for a tracking service like RealtyTrac or Foreclosure.com. You have found a number of properties that meet your needs, but you're not sure about the listing prices. How do you evaluate the asking price for a foreclosed home?

In order to make a smart offer, you need to review comparable sales in the area. This is what real estate agents refer to as "comps." This is one step in the process that's very similar to a regular (non-distressed) real estate transaction. You would look at recent home sales in the area to see what similar properties have sold for. You would then compare those trends to the property you are considering. This is how you determine the current market value of a home.

There's a good chance the foreclosure property will be priced below market value. Remember the average 27% discount we talked about earlier? If it's priced above the comparable sales, you should think twice about making an offer -- unless the target house has certain unique features that account for the higher list price.

4. Consider the Repair Costs, if Applicable

Homes get foreclosed upon because homeowners neglect their mortgage payments. And some homeowners will neglect the house itself. Some will become disgruntled toward the lender, to the point that they intentionally damage the house before leaving. This means you must do two things before buying a foreclosure property. You must evaluate the condition of the property, and you must consider the potential cost of repairs, if repairs are needed.

Foreclosed homes are usually sold as-is. This means the seller (which is usually the bank) probably won't honor any repair requests. If there's a lot of damage to the property, you could end up footing the bill for all repairs and/or renovations.

You should consider this additional cost when making an offer to buy the house. You might even want to offer a lesser amount to account for the cost of repairs. If you do this, just make sure you include an explanation with your offer. Seek your agent's advice on how to proceed with this.

Of course, the home may already be priced low to account for these costs. In this scenario, it would be unwise to reduce your offer amount. The bank might reject your offer outright. This is why it's so important to review comparables sales in the area, to determine how the target house is priced (see step #3 above).

5. Make Your Offer

Let's assume you've viewed the house and researched comparable sales. You're now ready to make an offer to buy the foreclosure home. This is a critical step in the process, and it's one where a lot of first-time buyers make mistakes. Here are the most important things to keep in mind when making your offer.

Have you been pre-approved by a mortgage lender? If so, you should include a copy of the pre-approval letter with your offer. If you don't include this documentation, you're leaving it up to the bank to determine your qualifications. This is a mistake. The REO asset-management people who work for the bank might contact you to ask about your financing. Or they might just toss your offer aside, in favor of one that does have a pre-approval letter attached. It only makes sense to show the bank you are financially capable of buying the foreclosure property. And that's why you should include a pre-approval letter.

Most banks provide detailed instructions for buyers on how to submit an offer. So, if you're attempting to buy a bank-owned home, you need to follow the submission guidelines to the letter. If you're trying to purchase a property at an auction, read this article next.

You should also be prepared for a bidding situation. Some banks will accept offers for a certain period of time, after which they'll choose the highest bidder. In other cases, they will contact all of the potential buyers to let them know a higher offer has been made. In other words, they'll try to get the buyers to outbid one another -- and thereby drive up the price. This is why you need to know (A) how much they home is truly worth in the current market, and (B) how much you're willing to pay for it.

Disclaimer: This article explains how to buy a foreclosure home. This information is provided for educational purposes only. It is not meant to take the place of professional real estate advice. Foreclosure laws vary from one state to the next. Before buying a foreclosed property, you should seek the advice of a real estate agent who is familiar with your local laws and conditions.